Minnesota City Spending Falls Further Below U.S. Average

Despite rhetoric from conservative policy groups, Minnesota's municipalities are exceeding expectations in terms of budget cutting. Per capita municipal spending in Minnesota has dropped further below the national average, based on the most recent "Census of Governments" data.* This finding provides municipalities ammunition in the debate over the status of Local Government Aid (LGA) as well as the broader argument over municipal funding and the need for property tax relief.

In 2007, per capita municipal spending in Minnesota was 22.2 percent below the national average. However, this statistic needs to be put in context because municipalities in some other states provide services that Minnesota municipalities do not provide. For example, the public school system is operated by municipalities in some states. Municipalities in these states should have higher per capita spending than municipalities in other states--all other things being equal--because they're providing a wider array of public services.

While there are potential pitfalls with interstate comparisons of municipal spending, a meaningful comparison between municipalities in Minnesota and other states is possible if we focus on a core set of expenditures that are common to municipalities across the nation. The following analysis attempts to isolate this core set by focusing on "adjusted municipal expenditures," which excludes functions that are not performed by Minnesota municipalities or performed to a lesser extent than in other states. Click here for a list of expenditures that are excluded in calculating "adjusted municipal expenditures" and the reason for their exclusion.

The graph below compares adjusted municipal expenditures per capita for Minnesota municipalities and all U.S. municipalities.

Adjusted municipal spending for Minnesota municipalities for 2007 was $1,121 per capita, 5.5 percent below the national average. Based on the previous Census of Governments for 2002, Minnesota was just 0.6 percent below the national average. Over a five year period, the per capita spending of Minnesota municipalities fell nearly five percent relative to the national average.

In real (i.e., inflation-adjusted) per capita dollars, adjusted municipal expenditures in Minnesota declined by 10.0 percent from 2002 to 2007. This information jibes with total revenue information compiled by Minnesota Management & Budget, which shows a 10.7 percent real per capita decline over the corresponding period.

The drop in Minnesota municipal expenditures since 2002 is almost certainly the result of a dramatic cut in the revenue that municipalities receive from the state. From 2002 to 2007, real per capita state aid to Minnesota municipalities fell by 34.5 percent--and this does not include the impact of additional cuts made after 2007. Previous analysis has shown that state government has solved a disproportionate share of its budget problems by reducing the revenue it shares with local governments, thereby producing higher property taxes and less funding for local services and infrastructure. Essentially, the state is balancing its budget on the backs of municipalities.

The trend in declining municipal expenditures in Minnesota relative to the national average is apparent well before 2002. The graph below shows the percent change in real per capita total municipal expenditures and adjusted municipal expenditures (i.e., omitting the excluded categories described above) from 1987 to 2007 for Minnesota and all U.S. municipalities.?

Over the last two decades, nationwide real per capita municipal expenditures have increased significantly, while in Minnesota they have fallen. The municipal spending decline in Minnesota based on U.S. Census Bureau data is comparable to the decline calculated using data from the Office of the State Auditor. In short, after adjusting for inflation and population growth, the spending of Minnesota municipalities is less in 2007 than it was in 1987.

As noted above, a portion of the decline in municipal spending is due to a reduction in state aid. However, the sharp decline in state aid is a relatively new phenomenon, commencing in 2003. The abrupt decline in Minnesota municipal spending relative to the rest of the nation prior to 2002 must have some other cause; one likely explanation is LGA reforms that were enacted more than 20 years ago.

Prior to 1989, the amount of LGA that a municipality received was determined in part by its levy in preceding years. Thus, a municipality that increased its levy (and spending) could receive additional aid in future years. It was argued that this system for calculating LGA provided an incentive for municipalities to increase spending. Thus, reforms were enacted to the LGA program that broke the connection between municipal spending and the amount of aid the municipality would receive; despite numerous changes since 1989, this characteristic of the LGA program has remained constant. About the same time, the connection between municipal spending decisions and homestead credit payments was also severed.

While the municipal LGA and homestead credit programs have morphed several times since 1989, the separation between municipal spending decisions and the amount of aid and credit payments that a municipality receives has remained in place. These reforms appear to have been successful in constraining municipal spending growth over the last 20 years, as evidenced by the preceding analysis. Even prior to the sharp aid cuts that commenced in 2003, real per capita municipal revenue and spending had been essentially flat based on data from multiple sources, while municipal spending in Minnesota has declined sharply relative to the rest of the nation.

Some state policymakers have suggested eliminating LGA on the basis that it encourages wasteful municipal spending. These criticisms need to be rethought, if not discarded, in light of the fact that municipal expenditures in Minnesota are below the national average. Since the implementation of reforms made more than two decades ago, real per capita municipal spending has steadily declined both in absolute terms and relative to the national average.

This is not to say that the LGA program cannot be improved. However, reform of LGA should be focused on ways to better target state aid to the communities that are most in need of assistance, rather than on further slashing LGA funding to shore-up state finances. After all, the state's fiscal mess is not the result of growth in spending on LGA, but rather a national recession combined with eight years of inept state fiscal management.

The above analysis of municipal finance data confirms that further cuts to LGA funding will produce the same results as in the past: higher property taxes and less funding for municipal services and infrastructure. Given that property taxes in Minnesota have escalated at the same time that municipal spending has dropped below the national average, there is no reason to continue solving the state's budget problems through disproportionately large cuts in state assistance to local governments.

*The Census of Governments is prepared by the U.S. Census Bureau and is released every five years. Municipal finance data from the 2007 Census of Governments was released last fall. As defined by the Census Bureau, a municipality includes "Organized local governments authorized in state constitutions and statutes and established to provide government for a specific concentration of population in a defined area; includes those governments designated as cities, villages, boroughs (except in Alaska), and towns (except in the six New England states, Minnesota, New York, and Wisconsin)." The Census Bureau definition of "municipality" corresponds with what are referred to as "cities" in Minnesota; in order to be consistent with Census Bureau terminology, this article will refer to Minnesota cities as "municipalities."

?Specifically, this article will focus on "direct general expenditures," which includes all municipal expenditures except for spending on liquor stores, public utilities, and insurance trusts. The analysis from last summer's article examined total expenditures, direct expenditures, and current operating expenditures, in addition to direct general expenditures. After consultation with Revenue Department staff, it was determined that the "direct general expenditure" category is most conducive to comparisons between states and over time.

?Municipal expenditures shown in this graph are based on direct general expenditures, as is the case throughout this article. The inflation adjustment is based on the implicit price deflator for state and local government purchases, which is the appropriate

measure of inflation for state and local governments. Some changes in Census spending categories since 1987 make the comparison of adjusted municipal spending in 1987 and 2007 problematic, but the potential inaccuracy resulting from these changes appears to be small.